Driving forward: The automotive sector is set to remain a vital economic contributor

With a track record dating back to Ford’s first assembly plant in 1925, Mexico’s automotive manufacturing has emerged as a key driver of industrial growth. It accounted for one-sixth of economic growth in the first quarter of 2013, according to PwC México estimates. The world’s eighth-largest producer and fourth-biggest exporter of vehicles, Mexico is a key supplier to the US and Canadian markets.

Eager to diversify beyond its North American Free Trade Agreement (NAFTA) partners, however, multinational brands and their suppliers are tapping the country’s array of FTAs, covering 44 countries and accounting for more than 35m vehicle sales annually, according to the Mexican Automotive Industry Association (Asociación Mexicana de la Industria Automotríz, AMIA). As assembly lines come on-line it will be key for suppliers, particularly in tier two and tier three, to follow suit with the required investments.

Size & Scope

The sector recovered swiftly from the global financial crisis, which saw production fall 28% year-on-year from 2.1m vehicles in 2008, with output recovering to pre-crisis levels by 2010 and growing 13.1%, 12.8% and 1.7%, respectively, in the next three years, according to AMIA. With output of 2.93m units and exports of 2.42m in 2013, the industry contributes 3.5% to GDP and 19.8% to manufacturing, up from 1.8% and 9.4%, respectively, in 1989. Centred on 13 clusters which together form the world’s fifth-largest exporter of auto parts, the industry is undergoing its fourth main wave of investments that will drive growth and diversification away from the North American market. The largest recipient of inward foreign direct investment (FDI) between 2007 and 2012, attracting $3.56bn in five years according to PwC México, the sector saw at least five new major original equipment manufacturer (OEM) investments, that will drive light vehicle output to 3.6m by 2016 and 4m by 2018, according to AMIA forecasts.

Mexican Waves

Investment in Mexico’s automotive sector is almost 90 years old. The first wave was driven by the “big three” US giants: Ford in 1925, General Motors (GM) in 1935 and Automex, which later became Chrysler, in 1938. The second wave of assemblers came in the 1950s, driven by Mexico’s import substitution drive, including Volkswagen (VW) in 1954, and Nissan and Kenworth in 1959.

From the mid-1980s onwards, as Mexico focused on opening its market and fostering export growth, the sector attracted Honda in 1985, Scania in 1992, Honda in 1995 and International in 1996. The small central state of Querétaro is symptomatic of the national industry’s growth, but also of the whole industrial sector’s reliance on automotive manufacturing. Investments started in 1964 when US-based Transmission Technologies Corporation established a plant to produce a brand of manual transmissions, before developing a second facility in 1978. US drivetrains manufacturer Dana Holding followed suit in the 1980s, although investment accelerated following the signing of NAFTA in 1994. While Japanese assemblers have a 40-year history in Mexico, they have been driving the fourth wave of investments since the mid-2000s. The world’s biggest vehicle seller, Toyota, opened its first plant in Baja California in 2004 to produce its Tacoma compact pickup, but the most significant new investment is coming from Mazda (part of the Toyota group) and Honda.

Investment Structure

There are 19 major global corporations with production lines in Mexico, particularly of cars and light vehicles like small buses, vans and pick-ups. The top five – Chrysler-Fiat, Ford, GM, Nissan and VW – account for 96% of both production and exports, as well as 74% of domestic market sales, according to PwC México.

Japan’s Nissan remains the largest manufacturer of light vehicles, with output of 683,520 units in 2012, and holds the biggest share of the domestic market at 25%, or 244,962 units. In second place is VW, which also features as Mexico’s largest car exporter, producing 604,508 vehicles and exporting 520,438. The German carmaker began building a new $1.3bn factory for its Audi luxury brand in 2013, with annual capacity of 130,000 units upon completion in 2016, near its existing plants for the Golf, Beetle and Jetta in Puebla state.

While the three oldest US car producers are the next three largest, they have been rebuilding their export base in Mexico over the past decade. GM is the third-largest producer, with output of 570,942 units and exports of 467,085 in 2012. Ford has increased its exports from 106,027 to 435,080 in the seven years to 2012, out of total output of 451,648, by investing $1.1bn in upgrading its plant in Baja California. Though Chrysler-Fiat is ahead of Ford in producing 455,334 units, having opened a new plant in Coahuila to produce Fiat Ducato vans, it ranks fifth in exports, with 420,780 units shipped in 2012.

The two other major Japanese players remain far behind in terms of both output and exports. Toyota exports the whole of its 55,661 output while Honda produced 63,256 units and exported 38,627, but their sizeable current investments should allow them to catch up over the next two years. The second Honda plant in Celaya, in the central state of Guanajuato, developed at a cost of $800m and employing 3200 workers, opened in February 2014. The plant will reach annual capacity of 200,000 units of its Fit subcompact hatchback and a crossover variant when it reaches full capacity later in 2014. The carmaker is also developing a $470m transmission plant, also located in Celaya, which will employ another 1500 staff when it opens in 2015.

A mere 25 miles away from Honda’s plant, Mazda is investing $770m in a plant producing 230,000 units annually when it opens in 2015, of the Mazda3, Mazda2 and a variant model for its mother company, Toyota. While Toyota will source 50,000 small units from Mazda’s factory, market research firm IHS Automotive sees in this a move by Toyota to test the waters before opening its own new plant in Mexico.

In the nearby state of Aguascalientes, Nissan opened a $2bn plant in 2013, with annual capacity of 175,000 units. In total the three Japanese producers will add 605,000 units to their combined output by 2016. The next OEM to enter the market is likely to be BMW. Since 2009 the company has been developing a network of suppliers in the country, Ivette Rodríguez, an industry reporter with Grupo Expansión, told OBG. In late 2013 there were reports that BMW was in the process of choosing a Mexican state to be the location for a new plant, yet the German carmaker’s announcement of a $1bn investment in the US state of South Carolina in March 2014 cast doubt on the rumoured project in Mexico.

Clusters

With 66% of assembled vehicles’ content supplied or added domestically, a network of 13 major clusters of suppliers and contractors has developed and generated activity in 23 other industrial sectors, according to AMIA. Already the world’s fifth-largest producer of auto parts, Mexico is expected to produce $79bn worth of parts in 2014, and some $92bn by 2019, according to the national suppliers’ association, the National Autoparts Industry (Industria Nacional de Autopartes, INA).

The largest auto clusters are the northern industrial giants of Nuevo León, Chihuahua and Coahuila, the state of Mexico and, slightly smaller, the central states of Querétaro, Guanajuato and Puebla. Central states like Querétaro account for roughly 6.3% each of the total value of Mexico’s auto parts production, including engines and transmission, over the January-October 2013 period. Querétaro alone accounted for $3bn of exports in 2012 and $1.8bn between January and August 2013, according to the state’s Ministry of Sustainable Development.

Roll Call

Most of the world’s largest OEM parts suppliers are present in Mexico. KPMG finds that 23 of the 25 biggest suppliers by sales value have a presence, while the government investment promotion agency ProMéxico reports that 84 of the top 100 operate plants in Mexico.

In total, the agency counts 2800 companies at three levels of contracting: tier one suppliers who sell components like engine parts, air conditioning, steering and suspension systems and electronics directly to the OEM manufacturers; tier two producers who sell parts including die casting, plastic parts and forged and stamped parts to tier one; and tier three firms that provide raw materials to tier two. Most of the suppliers, particularly tier one, are located near their OEM clients, creating a network of 13 large clusters around northern and central states.

Over the past decade, Mexico’s central zone has emerged as the second automotive cluster after the North. Indeed, 592 of the 2800 registered suppliers are located in the central states of Mexico and Puebla, according to the National Institute of Statistics and Geography. ProMéxico says that central states hold a strong lead in terms of seats, air conditioning, engine parts, electrical systems, hydraulics, metal-mechanic suppliers and interior components.

Competitive Advantages

Aside from an extensive network of FTAs and supply chain clusters, Mexico offers competitive advantages related to human resources, property and utility costs.

The country’s competitiveness in manufacturing has grown, particularly compared to China. Mexican unit labour costs (wages adjusted for productivity) achieved parity with Chinese costs in 2012 and are projected to be 30% cheaper by 2015, according to a study by Boston Consulting Group. While such projections may be optimistic, the trend of rapidly rising Chinese wages and the higher productivity of Mexican workers is clear.

The auto industry has added 100,000 jobs since 2008, reaching a force of 580,000 workers in 2013, according to AMIA. Given the industry’s long track record in Mexico, the number of universities with programmes to train engineers and technicians for the auto sector is large. These universities often have close linkages to industry. The Universidad Tecnoló gica de Querétaro, for instance, requires its students enrolled in programmes geared towards the auto industry to spend several months working in local plants or research and design centres as interns. Administrators and professors at the university also meet company representatives every year to revise the curricula and better meet the needs of industry. The federal government is aiming to support such linkages and plans to offer more scholarships for technological development at universities in 2014, according to PwC México.

Despite an uptick in real estate prices in some states, other operating costs in Mexico remain competitive and should benefit from reforms in other sectors. Industrial property prices in 2013 ranged from $35 to $48 per sq metre in Chihuahua to $30 to $70 in Guanajuato, $38 to $100 in Nuevo León, $45 to $80 in Querétaro and $54 to $98 in Puebla, according to consultancy Citius Capital. These rates remain broadly in line with China, where industrial land costs between RMB422 ($69) per sq metre in Tianjin to RMB521 ($85) per sq metre in Guangzhu.

In addition, the price Mexican factories pay for electricity is expected to drop once the government’s energy reform is implemented, which should further erode China’s price advantage. Mexican industry also has several natural advantages, including its location adjacent to the US market, duty-free access and lower transport costs.

Querétaro

The central state of Querétaro is emblematic of the industry’s rapid development over the past decade. With a mid-sized industry compared to the northern giants, the state counts around 300 registered companies according to the state’s Ministry of Sustainable Development.

This number includes 200 tier two suppliers, most of which are Mexican-owned, and 60 tier one manufacturers, which are predominantly subsidiaries of multinational companies. It also counts several tractor and heavy vehicle OEMs including MAN, Scania and Case New Holland Industrial, but no light vehicle plants. MAN has been producing truck, tractor and bus chassis in Santiago de Querétaro since the early 2000s, while Scania has centralised its Mexican production to Querétaro since 2006, producing heavy vehicle chassis. Case New Holland makes agricultural machinery and tractors in Querétaro.

The larger tier one manufacturers in the state include US supplier TRW, which assembles brakes and steering systems for clients including Ford and VW; Tremec, which is owned by Mexican conglomerate KUO Group; and Dana, which operates four plants producing drivetrains and components.

Growth in the state’s industry has been driven by new arrivals and expansion of existing players’ capacity, including TRW’s third plant in Santiago planned for 2014. Since 2012, Harman has produced entertainment and navigation systems for luxury cars at its new plant in Querétaro, while the US firm Shape has manufactured bumpers and fascia trim for automobiles. In 2013 Japanese auto electronics manufacturer Hi-Lex and Germany’s Novem Car Interior Design opened plants in the state, while several new factories are due in 2014, including Hitachi’s automotive brake plant that opened in March.

Part of the state’s attraction is its location, which, despite being farther from the US than northern states, is on the NAFTA highway. It also has logistical advantages, such as a lack of traffic congestion and the close proximity of many auto plants to the international airport. Meanwhile, Querétaro, like other central clusters, is relatively close to the ports of Veracruz on the Atlantic and Manzanillo on the Pacific, which will increasingly be leveraged as the auto industry seeks to diversify its export destinations away from over-reliance on North America.

Depth Required

While the clustering effect of OEM manufacturers and tier one suppliers has proved a draw, the efficiency of the clusters is hampered by a problem similar to the rest of Mexico’s industrial base. Manuel Cedillo, a researcher at the INA, said that as OEMs and tier one suppliers have proliferated, Mexican tier two and tier three suppliers have been unable to keep up with demand for components. In Querétaro, for instance, the number of tier two suppliers has grown rapidly, but they do not meet the needs of the tier one manufacturers nearby.

TRW are unable to source most of the components that their plants use locally and have very few Mexican suppliers. While the company has begun establishing relationships with more tier two contractors and evaluating their capabilities, with plans to place orders in 2014, significant hurdles remain, including quality, pricing and availability of raw materials. While many local suppliers are ISO-certified, they will also have to pass tier one manufacturers’ internal certification processes. They will also have to undercut TRW’s current suppliers on price. Although this will be challenging given that most contracts are negotiated on a global scale from headquarters in Michigan, the company expects to save up to 10% on Customs fees and transport costs for some components if a capable local supplier exists.

Meanwhile, raw materials are often a challenge to source locally, despite the considerable size of the industry, with TRW importing aluminium bars from Germany, for instance. The company is also exploring means of sourcing steel, aluminium and plastic locally for the first time in 2014.

The gap in the market is proving a draw for international tier two suppliers, following rising OEM and tier one investments. Since 2012 several foreign mould-makers have expanded to the Mexican market. Canada’s Integrity Tool & Mold opened a 19, 520-sq-ft facility in Querétaro in 2012, equipped with a 50-tonne crane. Ontario-based Concours Mold followed in March 2013 when it announced an investment of $5.5m to double the size of its mould plant in south-eastern Mexico. Two more investments followed in late 2013, with similar plans from US-based Frimo and Japan’s Ikegami Mold.

State governments, aware of supply chain deficiencies, are trying to raise standards and expand links between suppliers. Querétaro’s Ministry of Sustainable Development established the Office of Supplier Development to help tier two and tier three firms, particularly in the automotive and aerospace sectors, to undergo certification, develop contacts with potential customers and finance acquisitions of equipment. Many of the suppliers the office works with are Mexican-owned smaller firms, often with no access to capital, so it works with local banks to facilitate access to finance at lower interest rates. It also contributes towards the costs of certification and travelling to business development conferences.

Diversification

With output and exports steadily rising, OEM producers are eager to hedge the risk of over-reliance on North American markets that became all too evident in 2009. With over 82% of total production earmarked for exports, which account for approximately 23% of total industrial exports by value according to AMIA, any export slowdown has direct effects on the industry. The share of Mexican-produced cars in the North American market has risen from 6% when NAFTA was signed in 1994 to 18% in 2013, and is set to reach 25% by 2020, according to IHS Automotive.

The southern neighbour is set to overtake Canada as the single largest source of vehicle imports to the US by 2015, having overtaken Japan in 2012. Yet with an extensive network of free trade agreements with most of the Western hemisphere and markets like the EU, Japan and Israel, both producers and the government’s export promotion agency are seeking to diversify markets. This is evident from the structure of producers, with Japanese investors focusing on the central part of the country, with easy access to ports on both oceans, while US carmakers have clustered in the north along the border.

The industry has made progress in diversifying sales: the share of Mexico’s light vehicle output exported to the US dropped from 85% in 2002 to 68% in 2013, according to IHS. Meanwhile, exports to Latin America and Europe, which were virtually non-existent in 2002, have grown to 13% and 6%, respectively, by 2013. Yet some parts manufacturers doubt the extent to which Mexico will be able to diversify. “The auto sector has a ceiling on growth in Mexico as it is directly related to the volume of cars sold in the US,” Adriana Macouzet, president and general manager, North Latin America for PPG Industries, a coatings company for auto and auto-parts manufacturers, told OBG. “Once production capacity in Mexico copes with US demand, the pace of investment will fall. Growth in the sector should come through value-added processes.”

Meanwhile, although the domestic market has grown consistently, by 7% on average since 2010 according to AMIA, it is increasingly dominated by Japanese brands, whose market share has risen from 23% in 2009 to 42% in 2013. The three major US producers’ share fell from 57% to 35% in the same span.

Mexico’s auto parts sector is poised to benefit from growing investments by OEM producers. The central states in particular should capture a disproportionate share, given growing Japanese investment and their easy access to markets beyond North America. While rising industrial property prices could dampen longer term prospects, they should be more than offset by lower power tariffs and improving competitiveness in labour costs. Meanwhile, growing investments by tier one producers should increase incentives for suppliers to upgrade their capabilities. The extent to which the local supply chain develops, particularly among the tier two and tier three manufacturers, will be key to determining the longterm prospects of the country’s automotive industry.